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CAPITAL MARKETS
W
Stand
and default
According to Mohammed Khnifer, recent
Sukuk defaults could bring innovative
restructuring approaches to the Islamic
finance industry as the dilemma of
restructuring forces scholars and lawyers to
set aside differences and create Shari’ahcompliant restructuring plans
40
Islamic Business & Finance | OCTOBER 2010
hen there have been 21 confirmed
cases of default events in the last
21 months, then you know that
law firms are busy restructuring
the defaulted Sukuk as well as saving those who are
near to default.
When I initiated a series of research on the
so-called defaulted Sukuk last year, many scholars
I contacted told me that we would first have to
wait and examine the cases. In other words, they
needed some time to come up with innovative
Shari’ah restructuring plans. The problem was that
they had never seen large scale default events before;
hence their task was how to make the conventional
restructuring approaches Shari’ah-compliant.
Now for the first time, the Islamic finance industry
has had a firsthand look at these details. Basically,
there are three main approaches: haircut; extending the
maturity of Sukuk addition by two or three years; debt/
equity SWAP.
After examining most of these options, I believe:
approach one does not guarantee the recovery of the
principle. Worse, they will recover 70 – 80 per cent
without any profits. Approaches two and three also
do not guarantee the recovery of the principle, but
it depends on the flexibility of the agreement after
cancelling the original contact.
Haircut
Haircut is when the capital providers (i.e. Sukuk
holders) agree to make a discount in order to get early
settlement (Tanazul), according AAIOFI standards.
Sometimes certificate holders are forced to go
down the haircut route when the originator is in
severe financial distress, i.e. there is hardly any cash
flow from the underlying assets of the Sukuk (the
asset-based type). Therefore, extending the maturity
of the Sukuk is not an option.
To give an example from the conventional
financial system, Argentina offered last month 66 per
cent haircut on its defaulted bonds. Same thing with
Dubai World, which may ask banks to take a 20 per
cent “haircut” from the face values on their loans.
www.cpifinancial.net
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Extending Maturity
Certificate holders opt for this
approach when the financial position
of the company is too strong.
Nonetheless, this will raise the issue
of opportunity cost for the Sukuk
holders. Should the same situation
happen with bonds, the originator
will increase the interest rate on
the coupon payment in order to
compensate them for the opportunity
cost. However, with Sukuk, this is
not permissible. So, the question is
to come up with a Shari’ah-compliant
solution for the opportunity cost?
It depends on the nature of Sukuk.
If they are Ijara Sukuk then extension
means extending the lease contract,
which can be on new conditions which
may include higher rent. If they are
Musharakah Sukuk, then the term can be
extended and the ratio of sharing profit
may be changed.
For instance, Nakheel, the builder
of the palm-shaped islands off Dubai’s
coast, plans to issue bonds in midJuly to settle its debt to contractors.
The company said in March that trade
creditors would be offered 100 per
cent recovery of their claims – 40 per
cent through a cash payment and 60
per cent through a publicly tradable
Sukuk, paying a 10 per cent return
annually. In my view, Nakheel decided
to pay this high rate of return in order to
compensate the Sukuk holders for the
opportunity cost.
Debt-for-Equity Swaps
In a debt-for-equity swap, a company’s
creditors generally agree to cancel some
or all of the debt in exchange for equity
in the company. Debt for equity deals
often occur when large companies run
into serious financial trouble, and often
result in these companies being taken
over by their principal creditors.
This is where we see Shari’ah
restructuring innovation coming into
play. At the 7th Kuala Lumpur Islamic
Financial Forum 2010 (KLIFF 2010), Dr.
Mohamed Daud Baker spoke about debt/
equity swaps. He said that the “Sukuk can
be converted into equity of the issuer”.
Personally, I think what he meant
by the issuer is the originator as the
issuer is the SPV. My interpretation to
his brief statement is that Sukuk is not
debt, it is equity as you take ownership
in the underlying assets. In case of
default, you can convert equity (of the
underlying assets) into another form of
equity (of the originator) at a formula
agreed to both parties.
Dr Mohamed Elgari concurs with
my interpretation. He said, “Since the
Sukuk holders do own assets which
can be sold to the originator or the
third party then they can use the value
to purchase shares (i.e. convert to
equity) of the originator who is now
the purchaser of these assets.”
As we explore the restructuring
approaches for any defaulted
Sukuk, one should mention
Mohammed Khnifer is highly regarded journalist and researcher specialising in Islamic
finance. He holds of an MSc in Investment Banking & Islamic Finance from ICMA Financial
Studies Center at the University of Reading’s Henley Business School, UK, and is a Chartered
Islamic Finance Professional (CIFP), accredited by INCEIF. By 2011, he is expected to have earned
his MBA in Islamic Banking & Finance after winning the Silver Scholarship Award from Bangor
University. For the past seven years he has been in charge of the editorial content for the Islamic
banking section of Al Eqtisadiah Saudi Newspaper. Khnifer is frequent guest to numerous and
prestigious Islamic finance conferences and his research papers are published worldwide.
He can be contacted at [email protected]
www.cpifinancial.net
Now for the first
time, the Islamic
finance industry
has had a firsthand
look at these details.
Basically, there are
three main approaches:
haircut; extending
the maturity of Sukuk
addition by two or
three years; debt/
equity SWAP
the choice of replacing the old securities
with new issuance. For example, you
can issue new Sukuk in order to repay or
redeem the old Sukuk.
The Sukuk industry is on its way
to maturity, despite the fact that there
is a need to educate investors on
these sophisticated instruments. The
industry needs to recognise, as well
the next generation of Islamic bankers,
the vital role that needs to be filled in
Sukuk origination.
OCTOBER 2010 | Islamic Business & Finance
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